Call and Put Selling – A Follow-Up

As promised, I am revisiting some put and calls sales I wrote about in October 2009 and May 2010. In October 2009, I advocated selling covered calls on stocks to take advantage of a market that had risen substantially in a short amount of time – little did I know that it had far higher to go. After a strong pullback in May 2010, I suggested writing puts to take advantage of a weaker market and higher implied volatilities (higher prices, in other words) in options.

Before looking at the results, note that there was nothing particularly clever about the selection of stocks (the 12 largest stocks in the U.S. by market capitalization at the time the first article was written) or the timing (I suggested selling calls after a significant increase in the market and selling puts after a significant decrease). The following chart shows that I was not nailing any tops or bottoms.

The table below shows strike prices of the options sold and the premiums received as well as the underlying stock prices at the time of option sales and currently:

Half of the stocks would neither be put nor called, leaving the investor in the same position as in a passive strategy, except for the joy of pocketing the option premiums. The shares that exceeded the call strike prices at expiration and therefore being sold were WMT, AAPL, GOOG, IBM, and PG. Only BAC shares ended lower than the put strike price and would therefore leave the investor with a double dose of that troubled bank. The portfolio can obviously be rebalanced at any time.

Even though the market may have proven my outlook at the time of writing the first article to be overly cautious, the results of the overall strategy are still quite impressive. The strategy using option sales would have returned over 23%, compared to 13% for the passive strategy, dividends excluded in both cases. Remarkably, the passive approach turned out to be better for only one stock, AAPL, and in no instance did the options strategy result in a loss, whereas the passive investor would have suffered losses on BAC and JPM.
At the right end of the table above, breakeven points are shown. If the stock price was below the lower limit at expiration, it would have been better not to use this strategy (due to a large loss on the puts), whereas if the stock price was above the upper limit at expiration, it would have been better to simply hold the stock and not limit the upside by selling calls. It would take an extremely strong or weak market for this strategy to underperform a simple buy and hold strategy. It is really only the extremely weak market you need to worry about. For instance, having a large amount of put options outstanding from late 2008 to early 2009 could potentially have been devastating. Therefore, position sizes and risk control are key.
Again a Good Time to Sell Covered Calls
Since the market has had an impressive and almost uninterrupted winning streak recently, it seems prudent to sell covered calls again at this time. I will repeat the exercise in a similar way by showing the twelve largest U.S. stocks by market capitalization currently and suggesting covered calls to sell with an expiration in January 2012. Between now and then, I will look for a time of weakness to sell puts against the same stocks. The results will be shown in a year’s time.

Disclosure: Author is long MSFT, AAPL, JNJ, BAC, T.


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